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Helicopter Ben at work

Not many people realize just how utterly unprecedented the Global Financial Crisis was.

To see just how singularly anomalous those months were, let’s revisit an article I wrote for 321 Gold in November 2008.

The graphs below are extraordinary, jaw-dropping plots. At the time I was watching them grow week by week, and was amazed that they were not “everywhere”. I still remember the chill I got in mid October when I first saw the ballistic spike. We’re talking about the money supply of the worlds largest economy. The rescue package blew away the scale — the second graph below covers 90 years. It’s not often you see any graph which is a true hockey stick. This was originally published at 321Gold on Nov 25th 2008. Remember this money (your money if you hold US dollars) was “injected” as a temporary fix (in theory), the plan was to neutralize it, or sterilize it, or insert-your-favourite-euphemism-here-for-getting-it-back-to-normal.

So where does the Money Base graph stand now? It’s not back down to $900 billion (where it was in August 2008), it’s not even stable at $1500 billion, it’s $2000 billion. Our markets run on ever increasing injections of new money. The people in the center of these markets–the banking class (many of whom are Wall Street types with big bonuses)–are the same ones who want a carbon trading scheme.

I pointed out that Ben Bernanke’s Helicopter (also known as the US Federal Reserve) was dumping dollars on the bankers. As a corollary, that had to be good for the gold market. At the time gold was selling for around US$700 per ounce. Tonight it’s $1220 (a 75% rise). Not many other market sectors can match that. On another day I’ll explain why gold is the only currency that governments can’t control (in the long run), and why it’s more important than the economic politically-correct litany would suggest. For the moment, ask yourself why the Money Base data is not reported on the front page of newspapers?

By the way, did you get some of the cash stashed in that rescue package?

Ben’s Helicopter Drop is Here
…and it’s Good for Gold

Joanne Nova

Nov 25, 2008

This is a graph to take your breath away.

St Louis Adjusted Monetary Base 1984-2008

This is what the start of hyperinflation would look like.

This is the US money base – the total of all currency and reserves of commercial banks in the central bank itself. It’s the narrowest form of monetary aggregate (but getting fatter fast). Banks create loans from base money, so in theory this recent expansion should turn up in broader monetary aggregates in the future.

Ben Bernanke earned the nickname ‘Helicopter Ben’ in 2002 when he repeated Milton Freidman’s comment that money could be “dropped from helicopters” if needed, to avert a deflationary depression. As a student of the great depression Bernanke has also been outspoken about his desire to avoid repeating the mistakes of that era, meaning he’d strongly prefer inflation to deflation.

Because the gold standard was dropped in 1971, money can be effectively created out of thin air. So it is no surprise to find that since September, newly created money has been raining from the sky. (Apparently this rain falls only on banks and a few large financials.)

The scale is unlike anything seen since the US Federal Reserve was formed in 1913. As the weeks progress on, all previous giant distortions shrink to goosebumps as the scale of the graph is redrawn.

In the two months after September 24th, over 550 billion new dollars were made from thin air and added to the US money base. That translates to 58% growth of the total US money base in just two months. (Annualized, that would be 350%. Watch out Zimbabwe.)

Most years, base money grows at around 1-2% per month and has only grown faster than 5% per month a few times. But the graph line ‘went vertical’ in September, (then got worse in November). The growth in money supply since then was larger than the total money base that existed in 1999, and it was twice as fast as the worst single month during the depths of the depression or the height of World War II.

St Louis Adjusted Monetary Base (AMBNS) 1918-2008

It’s not often you can see one month changes that dominate a 100-year graph.

The potential rapid inflation in the US dollar that is likely to come from such a massive dilution of the currency can only be good for gold and silver – the only currencies that can’t be easily diluted.

There are now potentially 100% more US dollars for each gold ounce than there were in total in 2003, and here’s the scariest part: there are now 50% more US dollars in the monetary base than there were seven weeks ago.

Nov 24, 2008
Joanne Nova

Yada yada yada… This is not investment advice. It does not represent a recommendation to buy, sell or hold any security.

ADDENDUM:Tim suggests the graph is misleading because it doesn’t use a log axis. It’s an interesting thought, but I disagree, for two reasons.

As I stated in the text, I have looked at this month by month, and calculated the percentage growth, which was twice as fast as the worst single month during the depths of the depression or the height of World War II.

The public need to know what’s happening to their money in the simplest most understandable form there is. That doesn’t mean a log graph isn’t also useful, but let’s start with the basics.

That said, it’s useful to see the month-by-month percentage changes, which I calculated and used in the Carbon is a Fiat Currency paper last February for SPPI. It’s still a hockey-stick. As I said, the scale of the interventions is not like anything that’s been done before.

Thank you Joanne for this graphic illustration of the US money supply.

I suspect that the St Louis Federal Reserve Bank is a good proxy for the entire U.S., and maybe not too far from generally representing much of the rest of the world. I am not an economist, but we are living in financially scary times. My take is that is is just a matter of time before the bubble bursts.

Thanks Tim for reminding me I had another graph I had forgotten about that is useful (see the ADDENDUM I’ve just added to the post). Rest assured, in percentage terms the recent growth is like nothing that has ever been done before (in the US since the start of the current Federal Reserve).

I had looked at the log graph at the time. Think of how big WWII was. Ponder that the US economy needs more debt percentage-wise to keep it afloat now than it did then.

Joanne, when we are in a liquidity trap expanding the monetary base has very little or no effect on prices. Japan almost doubled theirs between 1997 and 2005 and…prices just kept on falling. It was similar in the during the 1930s. See here for graphic and more comment. Core inflation is the US is still heading towards zero.

Roger: Japan was not floundering at the same time as the rest of the world was hitting the straps too. There was no Greek rioting. No question of sovereign default. The money Japan created went into the yen carry trade, so it may not have pushed up prices in Japan, but it spread out all over the world instead. Right now, we’re dealing with a global phenomenon.

And yes official CPI is down, but if you calculate CPI the way the officials used to 30 or 40 years ago, the CPI could come in much much higher, say, 10%. (I know that sounds extraordinary, but just as with “official” climate science, there are plenty of definitions and factors that can be adjusted or reweighted to keep the line on the graph following the trend that they want the public to see. The lower CPI is not all it seems, see Shadow Stats.)

Beranke has said he will do everything in his power to avoid a deflationary depression. Yes, thanks to the law of unintended consequences, it still might happen, but which government in the world will not fight that pain to the end? Which government will choose deflation, if they can score votes by posting money to the public en masse and saying, Go Spend?

If the people won’t take out loans, they will find it hard to turn down “tax refunds” that turn up in their mail box. It’s already started.

I’m glad to see a good discussion going, but unfortunately I’m going to have to step out now… til later.

Roger, inflation is not defined by rising prices, which are only a symptom of inflation. Inflation is an excess of money available for the amount of goods available. Core inflation is now massive, even though it is not yet reflected in prices, because banks are still sitting on their newly printed money supply and China is absorbing a lot of it. And, by the way, Paul Krugman is possibly the worst source to get economic analysis. Read Peter Schiff, instead.

Tax refunds turning up in the mailbox are different: that’s fiscal policy, For sure dishing out money like that will have an inflationary effect (as you say, helicopter money). Standard monetary policy in which money is sued to purchase assets is different – which is what we are talking about in the first instance. When an economy is depressed, with high unemployment, what exactly is the mechanism by which the prices of goods are forced to rise? When financial assest are fairly close substitutes for money, which is the situation at present (modulo the sovereign risk, granted), how does this exchange leads to higher prices? I don’t see it.

Jim: so Friedman was right after all, money growth does lead necessarily to inflation (it kind of follows from your definition).

Having experienced the higher inflation of the 80′s, my retirement nest-egg looked like it will likely be hard-boiled by the time I get to try and enjoy it….

The debt to GDP growth is worrisome, especially as it relates to having government spending replacing (pushing out) investment spending (from savings or business). The government never gets value for money but is heading for negative impetus as it taxes and spends us into the economic stone-age.

China and its debt-holding effect on the US economy will be an interesting and unique (never before experienced) event to live through.

The bankers are crooks but there isn’t anything bad on the explosive monetary expansion in 2008. They could be blamed only for information withdrawing. They knew how bad it really was while doing those desperate actions as the monetary expansions but they pretended everything is under control. Nevertheless, the money supply explosion was an adequate to the situation. If they didn’t the crisis would get much worse due to devastating deflation. It is not a paper spook from economy fairy tale books. It’s a monster if it comes to life. The money amount is not the only monetary base. The important value is actually product of the money aggregates with number of turn outs of the money. If money turn-outs are slowed down due to recession it is the same like if a great deal of money vanished. And if the money need wouldn’t be compensated by the monetary expansion terrible lack of money with monstrous deflation would get to rioting.

And a huge deflation isn’t a paradise for consumers. It means producers are driven to produce under their costs. That means businesses are being closed and zero investments. The crisis is actually a consequence of insufficient investment and nothing but investments can surmount it. Thus deflation isn’t desirable.

But the bankers behaved very badly. They knew the crisis was coming and it is only a step away, but they were actually contra-alarmists. They knew the situation but kept it in secret and they have been pretending their surprise of the crisis up till now. There were reasons for an alarm but they calmed down the public and they keep being hypocritical about their assumed surprise until now.

Exactly! Btw the Asian crisis was an overture to the current global crisis. It is probably the Kondratyev cycle crisis. The methods, how to cope with the recession, were finally tuned up with the Asian depression. And the monetary expansions as well as public deficits were accepted as very effective.

I figured the same thing out myself a year ago and bought gold mining companies in Australia, but a certain piece of crap wants to change the rules to confiscate their profits that come from the higher gold prices.

How do you hold gold? If you buy gold and hold it at the mint, and the piece of crap is returned to power, does anyone imagine that he won’t, when things go bad, just confiscate that too.

The US and Canada dropped the gold standard in 1933. Only the US actually made it illegal for Americans to hold gold and the US government set a fixed price of $35/oz for gold. This ended in 1971.
Whether it is gold or corn, backing a currency with a “standard” is a myth. Money is always “a promise to pay in future”, or in other words an IOU. Its value is totally dependent on a persons view of the future. A national currency (IOU) is backed by an assessment of the assets and stability of that country. Its natural resources, its people, its government. Relative to the rest of the world.
That is why the world rushes to US dollars in a crisis. A government can always come and take your gold away, but if people have faith in a nation (like the US for the last century), this faith will back its currency.

Sometime last century, a finance lecturer of mine passed the comment “And if there are problems in the credit markets, run for the hills”. I did and my super account is very happy that I did so.

Just a piece of completely unqualified advice.

Be careful holding large amounts of gold. If you can, make sure it isn’t registered (I don’t know if there is a way to do this). Also be careful of companies offering to both sell you gold and store it for you. Ask any New Zealander about Goldcorp and they’ll tell you why. Have the physical entity and bury it in your backyard or something.

During the great Depression, many americans who had gold had it confiscated by the government. I understand the intention was to ensure the fiat currency would remain.

Personally I think it is inevitable that the USD will be replaced by an alternative currency. I sincerely hope it will be tied to some physically tangible and limited resource. We simply cannot trust any government of the world to not just print more money when it suits their domestic agenda. I am unsure if it will be gold or something else.

The key to restoring confidence is by replacing the USD with something credible which is governed by an institution that can be trusted by people of all stripes and sizes. At this time I can see no such institution. Until this happens, globalisation is a dead man walking, IMHO.

This mess will take 5-10 years to sort out once the powers that be actually start to address the issue, and no, I don’t think the powers that be around the world have even started to address the issue. All they have done it try to alleviate the symptoms by making populist decisions – and some have even failed at doing that!

More problems than answers at this stage, I’m afraid to say on this one.

It is a wide-spread mistake with the 1971. Actually it was the system of the fixed exchange rate within Bretton Woods system that was abolished in 1971. The system included also fixed rates to gold for international clearing. It was not a gold standard for a currency but for the international clearing.

It’s deflation that we are seeing not inflation. This is obvious in that house prices are diving (and will here in Australia too) and that the M3 is contracting at a fairly severe rate now in the US (it’s slowing down here in Oz).

A good discussion of inflation/deflation by Professor Fekete is here. It’s not as simple as looking at the monetary base.

And gold is a crisis hedge not an inflation hedge as many believe. There was plenty of inflation from the mid 80′s to 2000 but the gold price decreased. People run to gold when nothing else (shares, real estate, bonds) looks safe.

leading story on ABC Landline Sunday featured joel salatin who, according to wikipedia. is “a self-described “Christian-libertarian-environmentalist-capitalist farmer”. here’s joel’s “christian” opinion of farmers, who no doubt make up a large portion of Landline viewers:

ABC Landline: Food for Thought
JOEL SALATIN, ORGANIC FARMER: So I’m a promoter of the Thomas Jeffersonian intellectual agrarian as opposed to just the hayseed, D-student hillbilly redneck that we’ve stereotypically banished to be the steward of our landscape.http://www.abc.net.au/landline/content/2010/s2919477.htm

never mind. ABC see Joel as “charismatic” – and Joel sees his potential “followers” in the same light!

TIM LEE: it’s easy to see why the charismatic American of a rapidly growing, global, grassroots movements of producers and consumers who want local, accountable, chemical-free and nutritious food….
(THIS IS FROM THE TRANSCRIPT BUT IS NOT GRAMMATICALLY SOUND)

JOEL SALATIN: They (shoppers)are ready to be captured by the imagination and the quality and the charisma of young bright-eyed bushy-tailed entrepreneurial self-starter farmers.

The current price of housing is not deflation. Housing was simply over valued due to government policy. Whole TV networks came about on the “Flip this house concept.” Obama, rather than let he price correct is trying to create another bubble. The government isn’t backing 0 down loans and giving 8 grand in cash to people because they want stability.

Overall, I’d expect to see deflation, but it is being hidden by our reckless monetary policies. You know a government is in trouble when it turns on the presses.

China, I agree, is soaking up much of the US M3 expansion (OK the Fed doesn’t do M3, but that’s more or less what we’re talking about). What you have to helicopter about this though is why. China is well aware of the trajectory taken by Japan and S Korea in the 1970′s and 1990′s respectively, and intends the same. Hence the 8-9% GDP growth target, being cooled back in range at the moment by a loan squeeze and bank capital requirement increases. They will continue to manage this until they’re around (non-PPP) GDP $10k per capita, which is another 10-15 years away (now its at about $3.8k give or take). Then they will try to carefully unwind somehow without falling into Japan’s deflation trap.

This is good because we may still have confidence crises like the GFC and this EU soverign debt crisis, but both are confidence crises, and have less to do with fundamentals (think of when Argentina went bust in 2002 – no GFC then). The bad news will be when China gets to where it wants in 10 or 15 years – then things might get really really wild.

Meanwhile they will be very careful managing their currency vs the USD because they already have well over $1t in treasuries, will be furiously buying more, and don’t like the idea of a haircut if the yuan sharply appreciates.

As an economist I was educated a long time ago. In post #5 you mention the CPI.

Most people do not know that the CPI now disregards food and energy inflation. Now those items cause pain when prices surge. Of course it is easy to leave them out.
Our gubment retirement social security is tied to the CPI. So leaving out energy and food costs causes us to get small increases in pay because it is adjusted to the CPI. Now seniors are hungry, cold and in the dark but they got a 1.9% bump in pension.

Food and energy prices deleted because they are too “volatile”. That is code for rising too much and too fast.

Now there’s one scary Hockey Stick, and it’s not even a projection. Thankyou for sharing this with us Jo. Now I wonder was there a similar effect on the Euro, or GB Pound, as the UK is in deeper deficit than Greece. ‘Quantitative easing,’ I think they called it. It must just be that stiff upper lip keeping them off the streets.

It all depends on how you define inflation and deflation as well. If you define deflation as a decrease in the velocity of money then that is certainly what we are seeing. What Bernanke is doing is pushing on a string, he’s trying desperately to cause inflation and get asset prices back up, but it’s just not working.
Everything is over-leveraged, the banks are severely over-leveraged and as asset prices (read houses) decrease their equity is being destroyed. The dirty little secret in finance is not that there is too much money but too little. The liabilities of the banks are so extreme, there is not enough money in the whole world to pay them. Bernanke can create money but he can’t make it circulate, thus it just flows into the black hole that the banking system has become.
Back in the depression they blamed it on a lack of gold. Now they’ve disconnected gold from the financial system we find out that it’s not the problem at all. Now we have a lack of money. In this system there will always be a lack of money because it encourages debts to go ever higher until the population just cannot support them any longer. Hence debt deflation which is a decrease in the circulation of money.

The United States is dumping a lot of money into circulation. The idea initially was to jump start the economy. By pumping a huge amounts of currency into the system the Fed was hoping to loosen the lines of credit and stimulate the economy. The TARP money and the extra dollars never made it to main street. Instead, the banks used it to buy smaller, more distressed banks and other undervalued assets. The U.S. economy is primarily driven by small business. Its main street, not wall street that is the true engine of the American economy. Had the government just given the money to the average citizen on a per capita basis instead of bailing out corporations that were “too big to fail” we may have seen some inflation but the economy would have been stimulated, tax revenues would have increased and unemployment would have decreased. Instead, the budget deficit increased, tax receipts decreased and unemployment skyrocketed. The economic recovery has been anemic.

What the U.S. called the great depression in the last century the rest of the world called simply a depression. Why? FDR instituted fiscal policies similar to what we are seeing now and it exacerbated the problem. Japan failed to face economic reality in the 1990s and the result was a moribund economy.

The U.S. is in a similar dilemma. If we do not allow a free market to “cull the herd” our economy will suffer the same fate as Japan’s only the magnitude of the debacle will be greater and the effect will be felt on a global scale. Moreover, the United States has increased its national to over 13 trillion dollars.

Many of the anti capitalists on the far left often point out that the U.S. has less than three percent of the world’s reserves of oil and gas (not true) and chastise America for using twenty-five percent of the planets energy. They lie by omission because they fail to mention that the U.S. economy accounts for twenty-five percent of the world’s GDP. As the old saying goes, when the U.S. economy sneezes the world economy catches a cold.

What is really terrifying is that the only thing backing the U.S. Dollar is the full faith and credit of the government. China has been running a trade surplus with the United States and holds vast amounts of U.S. Dollars, and Treasury Debt Instruments (IOUs). They are also acquiring strategic resources including oil, gas, minerals and they are paying hard cash for them.

If the U.S. continues on its current path we run the risk of hyper inflation and global economic collapse. OPEC trades oil in U.S, Dollars, for now. China holds the financial sword of Damocles over the United states economic neck. If push comes to shove they will wield it. True, their economy would suffer as the U.S. is by far their largest trading partner but out of the ashes of the financial holocaust a new world order would emerge with China as the sole financial superpower and the United States would become the world’s largest banana republic, an unstable regime with a nuclear arsenal capable of destroying the world several times over. Not a pretty prospect.

I am hoping the midterm elections will result in a massive change to the current political landscape. If not, and the U.S. continues on its current path of increased deficit spending I recommend that everyone learns chinese as a second language and prepare to barter as any fiat currency will almost certainly become worth less than the paper that it is printed on.

I wish to my friends in Australia and around the world of the old adage, when the U.S. economy sneezes the world economy catches a cold. If the U.S. economy collapses so will the world’s. As for me, I am the eternal optimist but I do live in the real world.

I have notice some posters referring to the U.S. housing market as being indicative of deflation.

The drop in equity value for most homes in the United States is the result of the housing “bubble” bursting, not deflation. Ironically, the bubble was created by the Fed lowering interest rates to stimulate the economy and end the recession of 2000. Artificially low interest rates made real estate attractive to investors. As the buying frenzy increased in tempo prices rose at an astronomical rate. Wall Street securitized the debt and marginalized it by a ratio of better than 20 to 1. This magnified the impact of the recession that ensued following the collapse of the housing bubble. The government intervened to stop the meltdown of the financial markets. It was the government intervention via extremely low interest rates in 2000 that instigated the worst economic downturn the world has seen since the great depression.

Traditionally, consumer spending is what normally gets the economy out of recession. However, the recent recession was so severe that it wiped out a great deal of discretionary income and depleted a large amount of consumer’s financial reserves. Americans are amongst the worst in the world at saving money in traditional savings accounts. The tight credit market has only exacerbated and compounded the problem. Unfortunately there remains the distinct possibility of a double dip recession or a depression.

Sadly, the politicians never seem to learn. Fortunately, people are beginning to see the light and American own over 57 million guns! Thank God for the second amendment!

Sorry but i think it is only a matter of time before the US officially goes broke.

You see the whole system works like a giant pyramid scheme, your gov borrows pieces of paper from the reserve and then pays interest on those pieces of paper so you need a never ending stream of new tax payers just to pay off the interest.

As new tax payers come online they pay taxes on all forms (income, and all other forms of gov revenue is tax) so the gov can pay off their debt which is why you have failed to plug the holes in your southern border because even Mexicans pay tax and they are cheap workers.

Unfortunately US companies like the ones here are greedy and all the high paying jobs (well even the low paying ones) have been sent off shore so there is not many people left that can actually pay any taxes, meanwhile your debt continues to spiral out of control and you borrow more money to cover your debts.

The last thing Saddam did before you/we invaded was trade oil in non US currency something which the Irain leader is doing now, Saudi is carrying a lot of your debt so they are holding out but it wont be too long before they start trading in other currencies. Once the dollar loses its “world currency” status it will quickly fall apart for you.

You will know when it is all over for your country, that will be the day you need a suitcase full of 50′s to buy a loaf of bread. Just think if Kennedy was not shot you would not have this problem as he was about to get rid of the Fed and go back to the gold standard. All is not lost though all you have to do is vote for Ron Paul this time.

Currency is just a promissory note of a person’s/company’s/society’s/country’s, productivity or ability to produce or willingness to produce. While value is subjective to what someone else is willing to pay for an object/thing/service under any given circumstance.

So making gold more valuable by linking this finite and rare metal, to the productivity of people or linking the same productivity to pieces of paper and printing more or less of them, is no different to each other in the long run… It is still people attaching “value” to them. Just different ways of looking at the two processes…..

Ultimately it is the willingness of a community of people to produce goods and services and trade in them, that makes objects/things/services “valuable”….. The enslavement of labor is thus the antithesis and undermining of true value and worth…. To a feudal king… Money was worthless, he owned everything and everybody anyway…. No matter how much work was put into making or producing it.

…. So where do we stand in the scheme of things in our brave new world of willing productivity?….. Is our labor being taken for granted, enslaved…… Debt is a form of enslavement….. if it is done TO you and not BY you. You meaning “the individual”.

I’d say this political class wishes to enslave us to THEIR debt…. We solve this problem by refusing to be productive for THEM and be productive for ourselves instead….. How this comes about is probably why the system has been crashed by the socialists in the first place by printing money to cover welfare…. They now seek to take control of it….. However they only seek to enslave our labor for themselves…. Stay with the free market, make sure it represents YOUR intrinsic value….. Not theirs.

Welfare is skewing the system… Money for nothing, to buy houses for nothing is skewing the sytem… Productivity for nothing and the enslavement of other peoples time and effort for other peoples benefit for no “valuable” gain… Time to curb it.

1. Great inflations often start with a period of deflation. After the government feels the pain they start to ramp up the rescue.
2. The CPI does not measure stock or house price inflation, and use hedonic accounting, geometric addition (not arithmethic), and changes in the weightings of items. It’s not a fixed basket, and just like calculating the world “Temperature” it’s as prone to human intervention and statistical games, except that there is even more money resting on it.
3. As far as unemployment and depressed businesses go, neither seems to stop inflation much in Zimbabwe.

There’s a few points missing from the explanation. China has been running a fixed exchange rate against the US dollar for many years in order to force Chinese manufacturing to be more competitive than US manufacturing (some would say “currency manipulation”). Ben’s helicopter drop was a bomb intended primarily for the Chinese, and it hit them two ways. Most directly, America can export inflation directly to China, and indirectly not only has the gold price gone up (gold is nice shiny thing, but you can live without it) but in parallel with gold, all mineral prices went up including the stuff that a heavily manufacturing-oriented economy cannot live without.

This leaves China paying more for minerals (yay Australia) and also subsidizing the US deficit. In theory the US is going to have to pay that back, but we all know the US dollar will simply devalue (it already has) and China’s decision making bureaucracy don’t have the agility to react rapidly to market changes so they just keep buying treasury bonds as the helicopter drops land on their hardworking heads.

In ages past we would just have had a war to sort all this out, but that’s looking a bit more difficult with increasing numbers of nuclear armed states.

Just watched an interview on the 7:30 Report. O’Brien with David Marr discussing our not so “dear Leader” now. Seems there’s an inherent rage in the man which comes to the surface on a regular basis.

In Copenhagen he apparently slept only one hour in forty attempting to put his stamp on the globe and couldn’t comprehend why the rest of the developed world did not fall into line with his magnificent obsession by destroying their economies. Perhaps even the smarter of the third world leaders understood that any bounty they received would be short lived.

The potential rapid inflation in the US dollar that is likely to come from such a massive dilution of the currency can only be good for gold and silver – the only currencies that can’t be easily diluted.

I’d be very wary of advice like this. Never buy currency. If you buy gold and silver do so because they are in high demand(or low supply) as a productive commodity. Not because they are viewed as a safe alternate money standard. Following this type of group-think can lead to financial ruin.

Eddy: Traditionally, consumer spending is what normally gets the economy out of recession.

Investment is what gets an economy out of trouble. Spending is used as a stimulus for investment. If you look at the capital investment figures of major corporations post TARP, you’ll see they have fallen off a cliff. Not only has the money been used to pay down debt and consolidate markets, that extra cash has reduced the ability of small business to make capital investment through profit taking. Any economist will tell you what should have been done was an undertaking to fix the US’s 50yr old infrastructure: roads, rail, bridges and ports.

@ wafffl 39
I agree that fixing the U.S. infrastructure would have been a good way to spend money on the governments part.

@ Tel36

Interesting observation on your part. If the U.S. does not reduce its deficit spending it will just be a matter of time before our credit rating is reduced which will make the debt too large to service and that will make it obvious to our lenders, primarily China, that sending us more money is just throwing good money after bad. Then, China and the U.S. will not have each other over the same barrel anymore. The U.S will take down the rest of the western world with it.

As a non-economist, here is how it looks.
Banks create a series of leveraged financial products which end up creating promissory notes for cash that does not exist. Why do they do this? Because they take bonuses TODAY for added value that may not crystallise for years/decades. And it’s ‘risked’, whatever that means.
Now governments are rescuing the banks for creating this ‘pyramid’ (that’s what it is). the risk is discounted by the government to zero (or worse).
So those of us who just save (low or no interest rate), or don’t have any money (increased taxes), have to subsidise this rubbish. No moral hazard.
What are the banks doing with the cheap money from the governments now? Still playing the markets and creating more financial products that give large bonuses. They don’t lend anymore to industry, which might make a difference but has pathetic bonuses.
So pyramid selling is being subsidised by our taxes and savings. Great.

Question: what would happen if instead of the current policy, we told the banks to get lost and just guaranteed actual cash on deposit? Wouldn’t it cost less? We wouldn’t be pumping money into a pyramid scheme. Is this wrong? Investors, bond holders etc who discount moral hazard to zero would be caught with their pants down.

Both options involve a crisis. The second is immediate and catastrophic to the banks and the over-leveraged countries riding their debt. The first will kill us all eventually with hyper-inflation, the only result of printing ridiculous amounts of money that has no basis in reality.

I hope some bright spark will tell me I’m talking rubbish. But I’ve bought gold just in case.

Lol – “utterly unprecedented” and all you have to back it up is a graph with data since 1910! outrageous.

The US Federal Reserve was only created in 1913, so yes it is unprecedented in the entire history of the Fed, without any exception whatsoever.

Early American coinage was completely referenced to silver, originally to Spanish silver, and then they started minting their own US silver dollars. There was a brief time when the silver standard slipped during the Civil War but it was caught up again afterwards. Using silver as a reference guarantees that expansion of the money is locked to a physical resource that cannot magically expand.

Of course, if you want to talk about countries outside the United States (e.g. Wiemar Republic Germany, or modern Zimbabwe) then ridiculous currency expansions are obviously not unprecedented, but I think it’s a fair reading to presume Joanne’s reference was limited to the USA, based on overall context.

Banks are offered by government a guaranteed profit if they lend money only to people who do pay off the loan and who never default. In return for this guaranteed profit, government takes a slice of bank profit as taxation (makes sense to take money from a bank, because the money is there to take). Thus, the bank makes a useful tax collector for government and the government makes a useful source of authority for the banks — a win/win situation for both parties.

Note the highlighted “if” which requires that the banks do actually collect their repayments from the punters in the field. Now and then, some punters sneak away without paying, or simply cannot pay because they don’t have the money. This is where the bank has no guarantee of profit anymore. If it happens a little bit, they just wear it and slightly crank up their interest rates so everyone else pays the difference. If a lot of default happens all at once, the bank is done for.

Thus, the actual useful job that banks do is to select from all the people who want to borrow money and select only the most trustworthy borrowers with the most viable plans (i.e. they manage risk). However, in the USA the government created Fannie Mae (and later Freddie Mac) as instruments to push the banks into taking on additional risky lending to low income earners, so they could purchase a much bigger house than they needed. That is to say, the government deliberately undermined the useful purpose of the banks in order to buy votes and encourage temporary social stability — low income earners could feel they were getting something out of the system.

The result took a while to wash to the surface, and by the time it did some snowballing had taken place (thanks to the Wall Street traders swapping one of these for two of those), and the additional influx of easy credit from China made it snowball even more, and George Bush’s pointless war spending just added to the overall load.

In a similar way to an overstressed bridge truss, once one spar broke the weight shifted to other spars which rapidly also broke.

Obama got handed the broken mess and his approach was to attempt to reinflate the bubble. The problem with reinflating the bubble is that the fundamental issue does not get fixed (i.e. people were offered loans who had no ability to pay back the loan). Thus, in the process of the reinflation someone must lose what they have. Maybe the investors will lose and people will get to keep their houses at lower repayments, or maybe China will lose and the US as a nation will default, but we now know that it is not possible to satisfy everyone in this equation. Inflation devalues all holdings and mostly clobbers the investors because the nominal value of the loan repayments stays constant but the real-world value is reduced.

In my opinion, the banks are partly to blame (because they neglected their most important duty of managing risk), but people should be just as outraged at what Fannie Mae was trying to do in the first place (bully the banks into taking bigger risks than they knew were reasonable).

I noted some of this on another thread, but I’ll put it here too, as it is more germane here.

The reason that the massive US government print and spend is not inflationary Right Now is that the banks have been told to raise capital. If you remember the fractional reserve banking system has a large multiplier effect at low reserver fractions. Raising the reserve fraction has a large money supply reduction effect ( a divisor, if you will). So the net effect it so let the government print and spend like crazy while NOT leading to immediate inflation from increased money supply.

The end game comes when the banks are at their new, higher, reserve requirements. Then the net increase in money starts to be inflationary. Also, the velocity of money dropped to near zero in the crash. It is rising now to more normal levels (but still low, especially in the form of business loans). As that velocity picks up (with increased lending after reserves stabilize) the fuse is lit for more inflation.

It is remotely possible that the government will suddenly massively reduce spending when that happens, but I’d not bet on it.

So as bank reserves stabilize and velocity starts to pick up, inflation will too.

BTW, the key difference between “money” and “currency” is that currency is a medium of exchange while money is also a ‘store of value’. That is why it’s call “paper currency”, it is not a store of value. Gold has intrinsic worth, so it is always a store of value, but not always a currency.

And in times of complete economic collapse, I’d rather have 100 ounces of tobacco than 100 ounces of silver… No, *I* don’t smoke… Soap, salt, tobacco, sugar. All are a store of value and in high demand in times of emergency. It’s easy to grow food, very hard to grow soap… especially the fancy scented ones.

So while I like gold, for an emergency store of value, I’d supplement it with some other commodities. (Look at the price folks pay for real vanilla and saffron, for example. Then go camping with the family and see how fast simple soap becomes of interest

In summary: we don’t have inflation now, but we are building in massive public expenditures in the future while reducing national wealth building ( i.e. business). The end result is ‘not pretty’…. and that will be inflationary.

Sidebar on Debts: The US Govt has a spectacular level of unfunded debt and unfunded obligations. These will ‘come due’ in the next 10 to 20 years. The USA will repay every penny it has borrowed and pay every penny of obligation. But it will do it by printing, not by increased wealth building. The only way to cope with several hundred $Trillion of unfunded mandates is to inflate it away…

Good analysis Jo but you need to explain why the injection has not created high inflation. People were confused in the fist months when no runaway inflation occurred. Many still are. The reason is simple the banks read the warnings from the Austrian School of Economics blogs and recognised the problem. The banks whacked the excess money into excess reserves with the FED and other equivalent central banks. The banks wont implement the Austrian Schools recommendations but they did act on the warning.
Excess reserves took the money back out of circulation. The catch is that while the FED pays a tiny bit of interest the process of putting this money into excess reserves is a loss making process for the banks. One or two have been closing their doors per week. They simply can’t keep the money there forever and some academics are talking about forcing the money back into circulation. Also with the Europeans trying to keep Greece from defaulting the presses there are running again. There will be a point where the dam holding in the excess reserves will break; at that point we will see 30-50% inflation and a massive global government default crisis. See Gary North and mises.org